High Yield Update: All systems still go
With all the talk of Washington dysfunction and negative bond returns, many investors may have missed the performance of high-yield bonds of late. As measured by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index, the domestic high-yield asset class returned 99 basis points in September, lifting returns for the third quarter to 2.28%. Despite the showdown-shutdown over Obamacare and the debt ceiling this month, the performance has continued in October, with the Barclays benchmark index up 1.69% through last Friday and 5.48% year-to-date.
I can’t say we are surprised. Federated’s model bond portfolios have consistently been overweight on high yield. As our high-yield team has been saying since 2009, the combination of sluggish but positive economic growth, solid corporate earnings and clean corporate balance sheets is tailor-made for the asset class. It is an environment that has helped keep defaults at historically low levels, and has generated positive returns from both high-yield’s higher coupon rate and the narrowing of the spread, or gap, with yields on comparable maturity Treasuries. The spread is currently about 475 basis points, down from 554 points at year-end 2012. We think it may reach 400 before the end of this year but we may be running out of time. However, we believe the narrowing trend will continue.
The high-yield story hasn’t gotten a lot of play this year. In fact, if you listen to the popular business media, the message has been to avoid all things bonds and, to some extent, all financial assets. From a contrarian standpoint, this isn’t such a bad thing—the lack of love helps keep valuations honest. The latest issue of Barron’s, however, did highlight high-yield’s performance this year and said coupon-style returns may be the most likely outcome this year and into 2014—a conclusion those of you who follow our product know is in line with our thinking. On both a relative and absolute basis, when it comes to fixed income, high yield should continue to be the best game in town.